The US is preparing to embark on a period of financial regulatory reforms, led by a new Administration in Washington, D.C. These reforms will have repercussions, for better or worse, throughout the world. The agenda for change is long and daunting. We at Dorsey & Whitney will keep you apprised as proposals, counter-proposals, and eventually new laws, rules and practices, emerge. As our first report, we review the current state of responses by the US Securities and Exchange Commission (the “SEC”).

“The economic crisis has challenged faith in our system of capital formation and allocation, a system that has proved over the long term to be the greatest for creating wealth the world has seen”, said Mary Schapiro, Chairman of the SEC, in her March 11, 2009 testimony before the US House of Representatives’ Subcommittee on Financial Services and General Government. She went on to state, “[f]or an agency charged with protecting investors, maintaining fair, orderly and efficient markets, and facilitating capital formation, we need to understand and learn from the events of the last year so that we can restore investors' confidence in our markets. This means that the SEC needs to act promptly, decisively, and with resolve.”

In her testimony, Schapiro outlined the steps the SEC has taken to address the challenges caused by the current financial crisis, including empowering the SEC’s enforcement functions to better respond to tips and other leads, enhancing the SEC’s risk-based oversight of the markets, and leveraging technology.

The SEC’s actions in response to the current financial crisis are discussed in more detail below.

Improving Detection of Fraud

The SEC’s prolonged failure to catch Bernie Maddoff’s perpetration of perhaps the greatest financial fraud in history, with estimates of US$50-65 billion in losses, has deeply embarrassed the SEC. According to Schapiro, the SEC needs to improve its ability to process and pursue appropriately the more than 700,000 tips and referrals it receives annually. The SEC has retained the Center for Enterprise Modernization to begin work immediately on a comprehensive review of internal procedures to evaluate tips, complaints, and referrals, with a goal of establishing a process that will more effectively identify valuable leads for potential enforcement action.

More Enforcement Actions

The SEC is aggressively combating fraud and market manipulation through enforcement actions. According to the SEC, there are more than 50 pending investigations in the subprime area alone.

Taking Action to Stabilize Financial Markets


The SEC adopted a package of measures to strengthen investor protections against naked short selling, including (1) rules requiring that short sellers and their broker-dealers deliver securities by the close of business on the settlement date (three days after the sale transaction date) and imposing penalties for failure to do so, (2) eliminating the options market maker exception of Regulation SHO (which Regulation governs short sales), as a result of which options market makers are now treated in the same way as all other market participants, and (3) expressly targeting fraud in short selling transactions.

The SEC also approved emergency rulemaking to ensure disclosure of short selling positions by hedge funds and other institutional money managers.

In close coordination with regulators around the world, the SEC issued an emergency order temporarily banning the short selling of financial stocks. However, this ban has expired.

Credit-Default Swaps

The credit-default swap (the “CDS”) market is largely unregulated. In order to improve oversight and infrastructure for the over-the-counter CDS market, the SEC executed a Memorandum of Understanding with the Federal Reserve Board and the Commodity Futures Trading Commission for dealing with central counterparties for over-the-counter CDSs.

The SEC also approved conditional exemptions to allow LCH.Clearnet and ICE US Trust LLC to act as central counterparties for CDSs, an important step to help promote efficiency in the CDS market and help stabilize financial markets by reducing counterparty risk.

Credit Rating Agencies

The SEC approved measures to strengthen oversight of credit rating agencies and ensure that firms provide more meaningful ratings and greater disclosure to investors. The SEC has also performed examinations that have lead to new rules to reduce rating agency conflicts-of-interest.

The SEC will hold a roundtable discussion on April 15, 2009 relating to its oversight of credit rating agencies. Discussion topics will include issues related to recent SEC rulemaking initiatives, such as conflicts of interest, competition, and transparency.


Other actions taken by the SEC include:

  • Issuing an emergency order temporarily easing restrictions on the ability of issuers to repurchase their securities in order to help restore liquidity to the markets. However, this order has expired.

  • Entering into a Memorandum of Understanding with the Federal Reserve to make sure key federal financial regulators share information and coordinate regulatory activities in important areas of common interest, including anti-money laundering, bank brokerage activities under the Gramm-Leach-Bliley Act of 1999 (which repealed part of the Glass-Steagall Act of 1933 and allowed commercial and investment banks to consolidate), clearance and settlement in the banking and securities industries and the regulation of transfer agents.

  • Supporting the Basel Committee on Banking Supervision's plans for new guidance on liquidity management practices.

  • Initiating examinations of money market funds to analyze portfolio holdings.

Enhancing Transparency in Financial Disclosure

The SEC’s Division of Corporation Finance asked financial institutions to provide additional disclosure regarding off-balance sheet arrangements and the application of fair value to financial instruments. The Division also sent letters to public companies in December 2007 and March 2008 identifying disclosure issues relating to fair value measurements and off-balance sheet arrangements.

The SEC’s Office of Chief Accountant, in coordination with the Financial Accounting Standards Board staff, issued additional guidance to clarify issues regarding fair value accounting, completed a US Congressionally mandated study of fair value accounting, and held public roundtables on this topic.

Looking Ahead

Schapiro stated that “[o]ver the coming year, we will also have an agenda that focuses on issues of corporate governance, including proxy access, risk disclosure, disclosure related to executive compensation; money market fund regulation; retail investor protection; and international cooperation.” We here at Dorsey will keep you informed of any developments in this regard.

The full text of Schapiro’s March 11, 2009 testimony can be found on the SEC’s website at:

The SEC’s summary of its actions in relation to the current financial crisis can be found on the SEC’s website at: